Motley Fool Hidden Gems Investing - Being a Net Buyer of Stocks, Investing in China's Middle Class

Episode Date: January 24, 2022

It's never easy to see your stocks go down, especially when the overall market starts the way it has this year. Jason Moser discusses the importance (and psychological challenge) of being a net buyer of stocks and opens up about his decision-making process to buy more shares of Cloudflare, before he and Chris Hill share two stocks on their respective watchlists that they are looking to add shares of next. Plus, Bill Mann discusses China's enormous middle class, why so many businesses are making a play for it, and the role real estate investing plays in China. If you're looking for stocks to add to your own watchlist, we've got 15 in our free Investing Starter Kit. For a copy just go to www.fool.com/StarterKit Stocks: NET, SBUX, TWLO, AMZN, NFLX, PYPL, SHOP, JD, NTDOY Host: Chris Hill Guests: Jason Moser, Bill Mann Producer: Ricky Mulvey Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

Chris Hill. Today on Motley Fool Money, we're all going to take a deep breath because this is one of those times when stock investors need to remember, this is the business we've chosen. You got this, now let's go to work. I'm Chris Hill, joined by Motley Fool Senior Analyst, Jason Moser. Thanks for being here. Jason Moser. Hey, thanks for having me. Later in the show, Bill Mann will be stopping by to take a closer look at China's middle class and investing opportunities. Let's start with the market in general. I saw something over the weekend, a financial firm compiled research on the language used during earnings conference calls,

and they've been doing this for nearly a decade. 2021 was a record in terms of profanity used on conference calls. I saw that and I thought, boy, if the market continues to fall, then this earnings season alone might obliterate that record. As you and I are recording this in the middle of the day on Monday, year-to-date, and look, it's early, it's still January, but year-to-date, the Dow is down 8.5 percent, the S&P 500 down 11 percent, the Nasdaq down 16%. This is one of those times, Jason, where as long-term stock investors, we got to take a deep breath and remind ourselves, this is the cost of admission and it doesn't feel good and I don't like opening up my portfolio and seeing almost entirely red, but this is

the cost of doing business. Jason Moser. You put it, I think, perfectly there. I'm with you. I don't like seeing all of my holdings getting pummeled, but it is the cost of doing business. It is the way it is. You got to get used to it. If you can't handle it, then you need to probably just invest in something like ETFs or index funds that can help smooth that out a little bit, but this is the cost of doing business, as you said. I will go back to just a few weeks ago, Chris. You remember our 2022 preview show, I said, hey, don't be surprised if this is a down year for the market. You have that old saw that talks about one of every three years in the market is down on average. It is just one of those

things. We've been talking a lot, I feel like a lot over the last several years about a lot of these valuations. There are just a lot of valuations that are just good businesses, but man, it seems like a lot of success was really pulled forward and that's for a number of reasons. I think there was certainly the interest rate argument, and now we're seeing that play out here because you're seeing investment banks like Goldman Sachs even talking about now that maybe we see more than four interest rate hikes this year, more than four. That's something I think that freaks a lot of people out. It causes some knee-jerk reactions, but you have to recognize that it is something that comes with the territory. I will say too, I've said this before,

I feel like you said long-term investor. That is so important because the longer that you remain invested, the less these types of pullbacks hurt. They just don't have the same psychological effect. If you've been investing for 10 years versus someone who's just started investing last year, for example, this just doesn't hurt as much because the chances are you've got a fairly well-diversified portfolio. The chances are you've got some good winners in there already. It's a lot easier to see that seven-bagger pull back to four-bagger as opposed to seeing a holding that's down 60%, 70%, 80%. The funny part is that probably the wealth that you're losing in that seven-bagger pulling back to a four-bagger, you're losing more wealth in

the process, but there's that psychology in play. It doesn't feel as bad because you're still sitting on some nice gains there. It's difficult in the present moment to teach people, to convince people to not panic. It is going to be okay. That's probably the biggest challenge we have in our job, but it is just the cost of doing business, as you said. Along those lines, if folks haven't listened to Saturday's episode, and the title of the episode is The Fundamentals of Financial Data with Tom Gardner and Eyal Kusner, that is an episode to listen to and probably bookmark or just hold on to because they really walk through the math behind volatility and dealing with this type of wild ride. I want to get to something that I know a

lot of investors are dealing with. We're getting a lot of questions about this. This is something I'm mulling over as an investor. It is the idea of I've got some cash, I've got some stocks that I own that are underwater. I've got some stocks that I own that maybe it's that situation you talked about, it's the seven-bagger that's now a four-bagger. I'm trying to figure out where to deploy my cash. The reason I wanted to talk to you today was, you had recently posted on Twitter that you went back and bought shares of a company you already own shares of, and that's Cloudflare, a cybersecurity company. I looked at that, Jason, and I thought to myself, he could have bought anything. He had some cash, he could have bought something new, but he decided

to go back and buy shares of something he already owned. I wanted to get a sense from you of that decision-making process. How did you figure out? Because again, I'm looking at some things where where I'm like, well, this is a winner for me, but it's pulled back. Maybe I should put some more money on it. And then I actually do have some of those stocks where it's like, wow, I bought this last year and it's 70% lower than where I bought it. Maybe that's where I should be applying my money. So let's talk about Cloudflare. I'm assuming somewhere you had a watch list and Cloudflare was on it. Yes. I mean, Cloudflare is a business that I have admired for a while now, and listeners and members of our services know it's a stock that I

recommended over a year ago. And so for me, Cloudflare, when I first bought shares of Cloudflare, I knew buying my initial position, I knew that wasn't going to be the last time I wanted to buy shares of Cloudflare. I basically was opening that position with the plan in place of adding opportunistically as I grew more confident in the business. And so, you know, one of the sort of behind the scenes things here, a lot of people may not realize is the way we operate here at The Fool. We have internal trading guidelines, right? We have guidelines that dictate when and when we cannot buy shares of companies. We do have to be aware of that. For a long time, Cloudflare, we weren't even able to buy it. It was a restricted stock. It was one that we had recommended.

We do that in order to remain transparent and not front-running, I guess is probably the best word for it. But we just want to make sure that we're putting our members first, And so, it finally opened back up. It had been locked down for a little while, so it wasn't even available. But I saw that it had been unlocked, and I thought, okay, well, now I can put this on my list as one that I could target if I really felt like I wanted to add to it. And I knew that I wanted to. And so, for me, it really boiled down to, you know, this is a business that I bought maybe a year and a half ago, and it's basically round-tripped. It's kind of come back to the initial purchase price, right? It had a wonderful 12 months there, but I think we all realized some of these valuations were

just out of control. You just take that for what it is. For me, it basically boiled down to it was a business that I knew I wanted to add more to when I had the opportunity. When I look at this business today versus the business that I first started analyzing a year and a half ago, this is a stronger company. It's a stronger business today than it was a year and a half ago. How do you quantify that? What are one or two things you saw in the business recently where you thought, okay, this is getting better? Was it a metric like, oh, their gross margins are improving, or was it something else? No, that's a great question. And for a business like Cloudflare, as many of these software companies are, you look at not only

the number of people that are using the service, but you also look at the growth in big customers, those customers that are spending more than $100,000 annually. You look at the really big customers that are spending more than $1 million annually. You look at those net retention rates, you look at the actual guidance. I'll refer to that, just guidance alone. They just recently, in the most recent quarterly report. They're guiding for revenue for the full year to be 50% higher than a year ago. You're looking at a business that just is growing. Furthermore, I think that with this business, one of the things with Cloudflare that's always just impressed me is leadership and their focus on the long-term. They're not managing this business for

Wall Street's expectations. They're basically like, look, man, we're going to invest in this business. We're not going to be profitable for a while, but we know what we're doing is the right thing and we're pursuing this massive market opportunity. If you're on board, great. If not, that's cool too, but they operate under this thing called the Bezos rule, which ultimately just says that new features that Cloudflare engineers build for themselves need to be built using their tools. Ultimately, they basically just frame it as eating their own cooking. They believe in themselves so much that they continue to operate under this Bezos rule. I think When you look at the success that Amazon has had with that mindset, Amazon is a very special

business. Those are few and far between, but Cloudflare certainly seems like a business that has taken a lot of those lessons from Jeff Bezos and from Amazon through the years, and they're trying their darndest to operate under that same sort of ideal. And to me, it's absolutely worth a shot, right? And so it was the sum total of all of those things, the metrics, the key performance indicators tell me this is a stronger business today than it was a year and a half ago. And now, I mean, yeah, you could say the business maybe doesn't look cheap, right?

I'm not going to sit there and tell you it looks cheap, but I think that the valuation looks very reasonable when I look at this and I think, you know what, this is a business I intend on holding. I hopefully can own this thing for the next 20 years. That's my mindset there. I think that when you can look at it from that perspective, it starts to make adding to some of those positions a lot easier. I know that for a lot of investors, the concept of a stock hitting a new low, which is information that's easy to get your hands on at any given moment, it's like, oh, it's now at a 52-week low. There's a temptation for some, and I'm guilty of this sometimes, of just thinking, well, I mean, how much lower can this

thing go? You and I were talking earlier today because the way that the market has gone over the past week in particular is starting to remind me a little bit of March 2020. I realize that was the early days of the pandemic. We have vaccines now. We're in a different place from a public health standpoint. But just in terms of the market environment and the frenzy, because that's what can be scary for us as investors when this is happening. It just seems like, well, this is the financial collapse, and here it comes again. But early in the pandemic, I remember you and I were talking about Starbucks, because Starbucks had been in the low 90s and it had fallen very quickly to the high 70s. I remember saying, well, this is cheaper, but this doesn't

look like a back the truck up kind of moment. But if this thing falls further, if this thing goes down to 60 or something like that, then I think that's where the emotion of the collective market has gone crazy. It's like, well, look, yes, these are uncertain times, but come on, this is a solid business underneath it. I looked at Starbucks today, it's the same thing. It's history repeating itself. It started the year at 116, it's now in the mid-90s. I don't think it's insanely cheap, but I look at this now and I'm like, well, if this thing goes to $75, I mean, come on. Yeah, that's funny you bring Starbucks up because that was when I finally actually bought shares of Starbucks for my retirement portfolio.

I was looking for some stability, some income via dividend, and I thought, you know what, I have no clue how I don't own Starbucks at this point. I drink so much coffee. I drink so much of their coffee. I really should own this business. And it finally got to the point where I just said, what are you doing? Just buy it. And that's what I did back then. I opened a position at Starbucks and I don't know, something like $55. And again, another position that I opened that position with the full-on intention of adding to it opportunistically as capital became available, as it becomes available. I'm absolutely certain that I will add to that position here. It really takes me back to that old saw that Warren Buffett, he said it, it was several years back. It

was in one of Berkshire's shareholder letters. He said, and I quote, if you are going to be a net buyer of stocks in the future, you are hurt when stocks rise, you benefit when stocks swoon." I think that's something that's very important to remember, particularly for younger investors. I put myself in that younger investor category still, Chris, and I'm going to put you in that category too. I don't think we're looking to retire anytime soon. Maybe the word creeps around our head from time to time, but generally speaking, I would say we're still trying to grow our wealth. I think that you need to look at this from the perspective of being a net buyer of stocks. It's so difficult emotionally to see the businesses that you

own getting hammered. But when you can look at it from the perspective of being a net buyer, you want to own these companies for a long time to come, it starts to make more sense. It's way easier to do it the longer that you've been doing it. I think that's one of the biggest challenges for a younger investor, for a newer investor. You have to go through this type of stuff to really actually understand it, and it can be very difficult. We say take the emotions out of investing, but that's probably the toughest part to it because it's your money. Nobody should care more about your money than you do. When you see these businesses taking a dip like this, it can be a little frustrating. But when you pan out and look at the bigger picture,

and look at the business, think about Starbucks, think about Netflix, think about Amazon, these companies aren't going anywhere anytime soon. I'm not telling you to go out and buy those three companies, please don't make that leap. I'm sure, I think you could probably do dumber things than buying those companies at the same time. You've got to frame it through that net buyer lens. I think that helps make more sense of it. Last thing, and then I'll let you go. I looked this morning, and as you said, we have trading restrictions here at The Motley Fool, And so, I checked through our internal platform to see if I could buy shares of several companies, and I was not able to buy any. So, I'm just going to share one that's on my watchlist,

and I would like you to do the same. For me, it's Twilio. I look at a business like Twilio, and again, I wouldn't be talking about Twilio right now if I had actually been able to buy it earlier today. But that's one where I just, sort of, look at it, I look at that management team. To me, that's a strong business. I understand that it was at a lofty valuation before, but that is very, very high on my watch list to buy the next time I get the clearance. What about you? I like that mindset, Twilio. Very good business, one that I own, one that I've recommended, one that I absolutely would like to add to if and when we do have the opportunity via our trading guidelines here. I don't want to add a new company in my portfolio. There are so many

businesses in my portfolio right now that I like so much and I want to add to those positions. For me, it's less about a new idea and more about adding to these companies that I own already. I mean, one that stands out to me, it feels like the selling is just overdone. I mean, PayPal just sticks out to me as one that's just kind of a no-brainer these days. I mean, it is one where you think about the market opportunity, you think about how people are moving money around and how they are managing their financial lives. PayPal, and Venmo, and Zoom, all of those brands underneath that umbrella. To me, PayPal,

it looks like a really low-risk, or I should say really a very attractive risk-reward scenario today. Jason Moser, thanks for being here. Thank you. The bold case for many stocks across a broad range of industries includes the same three-word phrase, China's middle class. If Company X can just capture the attention and consumer spending of China's middle class, well, you know the rest. Here to provide a better understanding of China's actual middle class is Motley Fool Senior Analyst Bill Mann. Thanks for being here! Bill Mann It's a classic tale, isn't it, really?

It is, and I was poking some fun. But on a more serious note, you hear this about Chinese companies like Tencent and JD.com. You also hear this about American companies like Starbucks. So, let's start with defining our universe. How big a population? What is this thing? Yeah, how big are we talking? So, whenever you talk about China and you talk about numbers, it always feels like a cheat code for a game, because the numbers are almost invariably massive. The Chinese middle class is currently, and it's defined as someone having $10 to $50 of spending per day. That's how they define the middle class. That's 707 million people estimated. That's double the

population of the United States. That's about half of the total population of China. The really crazy thing about this, and why I started with that classic tale, is, we've heard this for 20 years. 20 years ago, the Chinese middle class was 3% of the population, or about 40 million people. So, not only is it big now, but it has grown. You really could describe it as being exponentially in the last two decades. I want to go a little bit macro for just a moment. When you think about real estate in China, because that's one of the big economic storylines coming out of China, similar to the United States at the moment, from the standpoint of it's a hot housing market, to the point where there are some people, particularly younger people in China,

who maybe they want to buy their first home, but some of them are getting priced out. Yeah, it's a really interesting situation. For a long time, Chinese citizens, it was very difficult for them to own shares in company stocks. In a lot of cases, they weren't allowed to. The real estate market in China has been the primary way that they've been generating passive wealth. Whereas in the U.S., something on the order of two-thirds of households own real estate, in China, it's over 80%. What you have seen in that period of time is a lot of growth in the value of that real estate, especially in what are the tier one cities, the Shanghai, Beijing, Shenzhen, Guangzhou, that have increased 13%, 14% per year for more than a decade. That's

been great for the owners. It's not been great for the new households that are just forming now. It's not so different from the U.S. that way. You're right. In the places where real estate is most in demand, it is also very, very expensive. It's so difficult for investors in America to separate the politics between the U.S. and China, or just broadly North America and China, and business between North America and China. And yet, despite that, we did recently see a new partnership between Shopify and JD.com. Yeah. So, Shopify and JD.com have set up a partnership where all of the Shopify merchant customers now have access to the Chinese market through JD.com's infrastructure. One of the

really interesting things about JD.com is that they have spent billions of dollars making their own shipping network, making their own transportation network, literally overlaying on the top of what is still a rapidly improving Chinese infrastructure. They built their own. They want it to be essentially white glove service. Now, as opposed to having to take a year to get set up with shops in China or something of that nature, merchant customers at Shopify, without having to do anything, now have access to a new, what they estimate to be 550 million people, class, and market. There are a lot of really interesting partnerships that are going on with Western companies going into China. When you hear about, hey, we're

going to try and capture part of the Chinese market, a lot of people think that they need to own Chinese companies. I actually think that that is amongst the less-recommended ways that I would do so. Certainly, there are American companies, I mentioned Starbucks before, we could put Apple in there, Nike, Ford Motor, you could even put in there, in terms of American businesses that do get a decent chunk of revenue, or at least going after a decent chunk of revenue, and really making a play for that Chinese middle class. But if you look at those, they seem, as a group, to fall into a lower-risk, lower-reward standpoint. You think about companies like Qualcomm, AMD,

IPG Photonics that get, in some cases, up to 70% of their revenue from China. Those are not necessarily consumer brands, though, that necessarily folks in the middle class are going after. In terms of trying to capture the consumer spending of China's middle class, how should investors think about that? Boy, those are three pretty good names. I don't think if you were to say Texas Instruments, I don't think there are many people who would think of that as being a knife's edge investment, not something that is going to be made or broken over what's happening in China. The company in the S&P 500 that has the highest exposure and revenues to China is Wynn Resorts at about 70% because

they have casinos in Macau. That actually is a pretty high-risk investment just because of regulatory issues in Macau. But Qualcomm, Texas Instrument, 50% of their revenues come from China. To me, these are foundational companies for the growth and the development in China and the world. If you were to ask me, if you had a company, Company X, that was very important in a country that is growing by itself at 8% per year in GDP, is that a pretty good tailwind? I would say absolutely yes. Last thing before I let you go, what is a company you have your eyes on that we haven't talked about? I mean, there are a lot of usual suspect type of companies we've discussed here. But I know one of the things you like to

do as an investor is look for smaller companies, ones that are a little bit under the radar. What's one in China that maybe is making a play for the middle class that folks may be less familiar with? Chris, maybe this will seem like it comes from left field, but one of the companies that I think really has a chance to make a a huge, huge impression in China is Nintendo. Nintendo, a Japanese company, the ticker NTDOY here in the United States, one of the largest video game platform companies and video game companies. Gaming in China, even with the restrictions that they put in in the last year, is massive. It is very much a character and a platform-driven company. I think that

is a really, really interesting place to look to get more exposure in China. Bill Mann, thanks for being here. Thank you, Chris. That's all for today, but coming up tomorrow, Alison Southwick and Robert Brokamp bring their unique perspective to the topic every investor has to deal with, risk. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.